Debt Consolidation with a Personal Loan: When It Saves You Money

How Debt Consolidation Loans Work

A debt consolidation loan is money you borrow to repay multiple separate loans, leaving you with one monthly payment rather than several. When you use a personal installment loan for this purpose, you receive a lump sum at the start and then pay it back in fixed installments according to a set schedule.

Because a personal installment loan is a closed-end loan with fixed payments, you know exactly how much you owe each month and for how long. That can make budgeting easier if you were juggling several credit card payments with varying due dates and minimum amounts.

• You borrow a lump sum and use it to pay off your existing credit card balances or other debts.
• You then make one fixed monthly payment to the loan lender until the loan is repaid.
• The loan term (how long you have to repay) and interest rate are agreed on at the start.
• A major benefit is the convenience of one monthly payment instead of several.
• Debt consolidation can be done with a financial institution such as a bank, credit union, or online lender.

Sources: Consumer Financial Protection Bureau

Calculating the True Cost of Your Current Debts

Before deciding whether to consolidate, you need to know how much your current debts are really costing you. This goes beyond just the total balance you owe. For credit cards, you're likely making minimum payments that vary with your balance and interest rate, and the amount of interest you pay can change if your rate adjusts.

To compare fairly, calculate the total you'd pay if you continued making only the minimum payments on each card until the debt was gone. That includes every interest charge that accrues over time. You can find your card's annual percentage rate (APR) on your monthly statement; the APR reflects the cost of credit including interest and any fees.

• Gather the current balance, APR, and minimum payment for each credit card or other debt.
• Use the APR, not the nominal interest rate, when comparing products, because APR includes certain fees.
• Estimate the total interest you'd pay over the life of the debt if you only made minimum payments.
• Also consider the impact of any balance transfer fees or other charges on your existing debts.

Sources: Consumer Financial Protection Bureau

Comparing Costs: Credit Cards vs. Personal Loan

The key question is whether a debt consolidation loan will actually reduce your total interest. A debt consolidation loan carries an APR that includes the interest rate plus origination fees and other charges. Your credit card debt, on the other hand, is revolving debt with a variable APR that can change over time.

To compare, look at the APR on the loan versus the APRs on your credit cards. If the loan's APR is lower and you don't lengthen the repayment term unnecessarily, you may pay less in total interest. The example below illustrates how different rates and terms affect the total cost.

• Calculate the total cost of your current credit card debt (including interest and any fees) over the period you plan to repay.
• Calculate the total cost of the personal loan: the total of all monthly payments over the loan term, including any origination fees.
• If the loan's total cost is lower, you could save money—but only if you don't run up new credit card balances.
• Watch out for teaser rates on loans that may increase after a certain period, which would raise your costs later.
• Remember that a personal loan often has a fixed rate and a fixed term, making payments predictable compared to variable credit card rates.

1. In this scenario, consolidating could save you significantly in interest, but the exact savings depend on your specific rates, balances, and the loan term you choose.
2. Note: This example uses illustrative numbers. Your actual rates and terms will vary based on your creditworthiness and lender. Always run the numbers with your own figures.

Sources: Consumer Financial Protection Bureau, Discover

Factors That Influence Savings: Interest Rates and Fees

Several factors determine whether consolidating will save you money or cost you more in the long run. The most important is the annual percentage rate (APR) on the new loan compared with the rates on your current debts. Because APR includes fees, it gives a more accurate picture of the loan's cost than the nominal interest rate alone.

The length of the repayment term also matters. If you choose a loan with a much longer term than your current payoff plan, you may lower your monthly payment but increase the total interest paid over the loan's life. Some lenders feature teaser rates that are low for an introductory period and then increase, which can dramatically change the total cost.

Finally, be aware that a debt consolidation loan may come with an origination fee or other charges. Those fees are included in the APR, so they affect your total cost and your effective interest rate.

• Compare the APR of the loan, which includes interest and fees, against the APRs on your current credit cards.
• A fixed interest rate and fixed term can make your monthly payments more predictable.
• Extending the repayment term will usually lower your monthly payment but raise total interest.
• Ask about origination fees, prepayment penalties, or late fees before you agree to a loan.
• Consider whether you'll be tempted to use newly available credit cards, which can undermine your efforts.

Sources: Consumer Financial Protection Bureau, Discover

Effect on Credit Score and Approval Odds

Applying for a debt consolidation loan may involve a hard inquiry on your credit report, which could have a temporary negative impact on your credit score. The effect is typically small and fades over time.

Your approval odds and the interest rate you're offered will depend on your credit history, income, and existing debts. Lenders assess these factors to determine your creditworthiness. Your APR will vary based on your credit profile.

• A hard inquiry from your loan application may temporarily lower your credit score by a small amount.
• Check your credit report before applying to ensure accuracy and know where you stand.
• Lenders consider your credit history, income, and existing debts when setting your APR and terms.
• Your creditworthiness will influence the APR you're offered.

Sources: NerdWallet, Discover

Step-by-Step Process to Consolidate

If you've decided that a debt consolidation loan makes sense for you, here's a typical process to follow. These steps are informational, and the exact process can vary by lender.

1. List all the debts you want to consolidate, including balances, APRs, and monthly payments.
2. Check your credit score to understand the types of rates you might qualify for.
3. Shop around and compare loan offers from multiple lenders, focusing on the APR and repayment term.
4. Choose a loan offer that has a lower APR than your current average and a monthly payment you can afford without extending the term too long.
5. Apply for the loan, submitting any required documentation, and review the loan agreement for fees and terms.
6. If approved, accept the loan funds, which are typically disbursed as a lump sum.
7. Use the loan funds to pay off your existing balances in full.
8. Close or avoid using old credit card accounts to prevent new debt from accumulating.
9. Make your fixed loan payments on time each month and plan to pay off the loan by the end of the term.

Sources: Bankrate

Comparing Debt Types and Decision Criteria

When evaluating a debt consolidation loan, it helps to compare the fundamental differences between the debt you have and the loan you're considering. The table below summarizes key characteristics based on regulatory and lender descriptions. Your actual rates and terms will vary by lender and your credit profile.

Sources: Consumer Financial Protection Bureau, Discover